The present invention relates to selecting and tracking mutual funds and, more particularly, to a method and system for comparing mutual funds according to a power spectral density that incorporates fund growth and stability.
There are three basic factors that affect the performance of a mutual fund, including fund management, market conditions and fund investment strategy. The fund manager makes the daily decisions not only on what stocks/bonds to buy, but when to buy them. Thus, market timing is often the difference between gain and loss, between one fund and another. Whether this success or failure is a matter of skill or luck is not as important as the results achieved. A profile of the fund manager is, therefore, an important piece of information that should be considered when selecting a mutual fund. The record of annual performance of funds managed by the manager in relation to funds with similar investment objectives/strategies is a good indication of the fund manager profile. Some of the better known managers are documented in mutual fund research reports, such as Mutual Fund Forecast, Ruykeyser Report, and financial newspapers (Wall Street Journal, Investor's Business Daily, etc.). The fund manager should have had experience managing the fund under consideration for at least three years, in order to establish a definable record. During that period, the fund should have out-performed competitive funds by more than five percent (5%) to be statistically meaningful.
Market conditions represent all of the factors that affect financial investments, including the flow of funds into/out of the market (supply/demand), trend of interest rates, inflation, political climate, and most importantly, the overall psychology of the investing public. While analysts tend to look at the market from a “fundamental” or “technical” perspective, one alternative view is that the dynamics of the market is driven more by human emotional factors than by any other. In 1957, for example, the stock and bond markets both lost about 3%-5% of their value in two days on news that President Eisenhower had suffered a heart attack.
Clearly, the real value of stocks had not suffered to that extent from either technical nor fundamental considerations. Similarly, when investors are worried about the job market or rising inflation (early 1970's and again in mid-late 1990's), there are usually a number of days when the market loses 5% of its value in a single day. Newspapers and TV (e.g., CNBC) financial summaries report well on this factor. Fundamental market analysis refers to the study of corporation profits, debt, cash flow, market share, growth in sales, etc.—the factors that affect the basic value of a stock or bond. Technical analysis, for purposes of this disclosure, refers to a study of the ups and downs of a stock in relation to its “200 day moving average.” Technical analysis attempts to predict the direction and timing of a stock's movement, regardless of the reasons why. All of these methods have merit in evaluating stocks and bonds; they should be used in combination with one another in making the decision what to buy/sell and when to buy/sell. Mutual fund managers will apply these analyses to whole sectors (e.g., drugs, automotive, health care, etc.) of the market, sometimes concentrating an unusually large percentage of its portfolio in a few sectors that appear to present better potential for growth than all others. A fund manager must have this flexibility if it is to out-perform most other mutual funds.
Investment strategy applies to each mutual fund and can be discerned from the mutual fund prospectus. Strategies vary from aggressive growth stock funds to U.S. Government bond funds. Each investment type carries a measure of risk—ALL investments have some degree of risk to the principal amount of investment. Even bank accounts that are insured carry a finite amount of risk—risk that the insurance fund will have sufficient funds to pay off in the event of failure of the bank. Bank failures occurred frequently in 1929-32 and again in 1989-1992. The issue that must be addressed is the amount of risk that one is willing to take with the investment. To reduce the inherent risk in investing in stocks, bonds, real estate, etc., mutual fund managers develop a strategy of investing in a wide range of individual stocks, bonds, etc., so that losses due to poor performance of a few stocks will not severely degrade the overall performance of the fund. It is not uncommon for a fund to contain several hundred to a thousand stocks at any one time. Typically, the fund prospectus will indicate that the fund may not invest more than 5% of its assets in a single stock nor more than 25% in a single sector of the market. This is part of the strategy to reduce risk to the investor. Another strategy that a mutual fund uses is turnover of investments in the fund portfolio; it will use technical analysis to determine when to buy/sell its assets. It is not unusual for a fund to experience 50% to 200% turnover in assets in a single year, as the individual stocks go up and down. It is important to understand the investment strategy of the fund (objective) and of the manager (performance). The strategy of the fund and the manager is best determined by the annual performance (total return on investment) relative to the performance of similar funds (comparison tends to eliminate variances that all funds experience because of market conditions).
Analysis of the stock and bond markets by market research firms has determined that annual gains usually occur in only 25%-30% of the trading days each year. This fact should be used to temper frequent swapping of mutual funds, which occurs when a fundamentally sound mutual fund experiences some losses. This is especially true when one changes the investment from a mutual fund to money market funds; being out of the market may mean missing one or more of the big up days that occur without warning. (Unlike stocks, most mutual funds trade only at the closing price each day.)